IMF Executive Board Concludes 2013 Article IV Consultation with GuatemalaPress Release No.13/297
August 2, 2013
On July 25, 2013, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with Guatemala and considered and endorsed the staff appraisal on a lapse of time basis2.
Key developments since the 2012 Article IV Consultation have been positive. Growth has been robust, while converging to trend and the output gap is virtually closed. As commodity prices stabilized and domestic demand pressures weakened, inflation fell sharply in 2012—closing at 3.4 percent by December (compared to 6¼ in 2011). While subsequently inflation rose somewhat—to 4.3 percent by May 2013, owing mainly to domestic prices—it still remained within the central bank’s target range of 4.0±1 percent. The current account deficit declined to just below 3 percent of Gross Domestic Product (GDP) in 2012, from almost 3½ percent in 2011. Rising Foreign Direct Investment (FDI), as well as official and private capital inflows, more than financed this deficit. Net international reserves are in line with reserve adequacy metrics and the exchange rate is broadly in line with fundamentals, though with some signs of erosion of external competitiveness.
Monetary policy has been on hold until lately and foreign exchange intervention has declined. The central bank kept the policy rate constant at 5 percent until late April 2013, when it was lifted by 25 bps, with the aim of stemming incipient signs of inflationary pressures. The exchange rate fluctuation margin used to determine intervention was widened in late 2012.
The central government’s deficit continued to narrow in 2012 to just below 2½ percent of GDP, but not enough to prevent a further rise in the ratio of public debt to GDP to 24 percent, comparatively manageable but a significant burden for government finances, given the low level of revenues. Net financing shifted from primarily domestic sources to external flows, with the placement of an international bond of US$700 million at favorable terms and long maturity. Last year, a tax package was passed by parliament—yielding
1-1½ percent of GDP—and came into force in 2013. Claims against the reform have piled up before the Constitutional Court. So far these challenges have been largely unsuccessful, though associated uncertainties have weighed down on collections and possible amendments to the reform may erode revenues. A draft Competitiveness Law sent to Congress by the President grants fiscal incentives to firms incorporated outside Guatemala City, with possible significant fiscal costs in the medium term. Accumulated domestic arrears, which spiked in 2010, remain unresolved.
Though credit to the private sector is growing fast, the financial system remains solid. Financial soundness indicators are strong and new legislation has been enacted to strengthen the system further. In 2012, Guatemala was reclassified into the OECD’s “white list” of countries that have implemented internationally agreed tax standards. New measures to combat money laundering have led to an increase in prosecutions.
Guatemala has gained some ground toward achieving the Millenium Development Goals (MDGs), but poverty and crime are widespread. Modest-to-strong progress has been recorded for 12 out of 16 MDG targets. However, a third of the population is below the minimum dietary energy consumption, and chronic malnutrition of children younger than 5 years is pervasive at about 50 percent. At the same time, the level of informality is very high, while security concerns are very serious.
The economic outlook is generally benign. Growth is expected to edge up to 3½ percent in 2013 and 2014, reaching its potential rate, supported by ongoing buoyant domestic demand and healthy private sector credit. Inflation is projected to remain within the upper half of the central bank’s target range in 2013-14 before stabilizing toward the center of the band. The external current account deficit would decline to around 2½ percent of GDP into the medium term, more than fully financed by FDI and other capital inflows.
Risks are prevalent on the downside, owing to global uncertainties and domestic policy constraints. Weaker-than-expected growth in the U.S, a hike in global oil prices or shocks to neighboring countries could all depress output in Guatemala. The reversal of crucial elements of the 2012 tax reform or negative consequences from ongoing initiatives that introduce tax incentives could derail fiscal consolidation. Insufficient revenue mobilization could persist into the long term, deterring investment in physical and human capital. More generally, currently envisaged consolidation plans are not yet sufficient to stabilize public debt as a share of GDP.
Executive Board Assessment
In concluding the 2013 Article IV consultation with Guatemala, the Executive Directors endorsed the staff’s appraisal as follows:
Growth has been firm in the aftermath of the global crisis, fundamentals remain stable, and the near-term outlook is broadly positive. Economic activity is projected to be near potential, while inflation should remain contained and within the central bank’s target band. Nonetheless, risks to the outlook are tilted to the downside. External risks include weaker than expected growth in the U.S. which would weigh on economic activity, and a geopolitical oil shock that could impair Guatemala’s terms of trade and growth. Domestic risks pertain to policies, including a setback on the main items of the 2012 tax reform, or enactment of legislation that entails new fiscal incentives. Weak fiscal revenues could endanger fiscal consolidation and lower Guatemala’s resilience to shocks.
The anticipated broadly neutral fiscal stance for 2013 is appropriate while further monetary tightening may be needed. The deficit outturn this year is likely to be only marginally lower than in 2012 (and than budgeted). Since capacity is nearly fully utilized, the resulting virtual absence of fiscal impulses is deemed adequate. Shortfalls in multilateral loan disbursements and revenue also mean that central government spending will be lower than planned. With expenditure levels already low, efforts should be made to limit the reduction in outlays, and at least to protect social programs and investment. Improvements in expenditure controls are necessary to prevent further accumulation of arrears. Clearance of outstanding payment arrears must be subject to rigorous audit of the claims. Some evidence suggests that monetary policy stance may be, to a certain extent, accommodating. Thus, if inflation continues to rise, amid robust domestic demand, strong private credit growth, and abundant bank liquidity, the central bank should stand ready further to raise the policy rate and absorb residual excess bank liquidity.
Fiscal consolidation is necessary in the medium term to allow room for counter-cyclical policies and reduce vulnerability to shocks. Though public debt remains relatively low as a share of GDP, it has been steadily increasing since 2008 and it is quite high in relation to government revenue. Stabilizing the debt-to-GDP ratio will require a permanent improvement in the primary balance of about ¾-1 percent of GDP. A moderately paced adjustment beginning in 2014-15, with limited frontloading, would balance the need to shrink the sustainability gap against any negative consequences on growth.
Additional revenue mobilization and improvements to public expenditure management should underpin budgetary adjustment. Raising revenues is essential not only for achieving long-term fiscal sustainability, thereby anchoring macro stability, but also for boosting health, education, security, and infrastructure outlays, which are all critical to reduce high levels of poverty and raise the potential for sustained inclusive growth. Specifically, reducing tax expenditures, adjusting VAT rates, and further strengthening the tax and customs administration would help lift collections. Enhancing the transparency and efficiency of spending would permit directing limited resources to priority areas, a goal that could also be supported by reforms to lower revenue earmarking and facilitate the approval of official external financing.
The monetary policy framework should be upgraded, including by enhancing exchange rate flexibility. Strengthening monetary transmission would make it easier for the central bank to reduce the volatility of inflation in response to external shocks and thus help maintain it at moderate levels. To this end, it would be important to buttress further the central bank’s operational independence and the soundness of its balance sheet. Efforts to de-dollarize by allowing more exchange rate fluctuation, developing domestic securities markets, and refining monetary operations are all critical for augmenting the monetary transmission mechanism. Likewise, more rapid progress in allowing greater exchange rate flexibility would reinforce the role of inflation as the primary objective of monetary policy.
Further financial sector reforms are desirable while keeping careful watch over recent strong credit growth. Though much progress has been made, financial regulations should continue to be modernized, with special emphasis on full implementation of risk-based and consolidated supervision, gradual introduction of the Basel III framework, passage of the law for micro-finance institutions, and enactment of Anti Money Laundering/Combating of Financing of Terrorism measures such as the banking secrecy law. Though not an immediate danger, the authorities should remain vigilant over high rates of growth of credit to the private sector—especially rapid expansion of consumer credit by micro-financial firms and foreign currency credit. Indeed, if sustained over a long period, a credit surge could eventually undermine financial stability.
High levels of poverty should be reduced by increasing social spending and by reforms aimed at boosting growth and regional integration. Higher social spending is essential to lift human capital, thus boosting competitiveness and growth, which would also be stimulated by greater public infrastructure expenditure. Private investment should also be raised through structural reforms to improve the business climate and reduce violence and impunity. The Public-Private Partnerships initiative should be strengthened to foster greater investment and improve infrastructure while managing fiscal risks. The recent congressional approval of the EU association agreement will help spur regional trade integration and the customs union.